Two Stocks Peter Lynch Might Like

11/03/2010 12:23 pm EST

Focus: STOCKS

John Reese

Founder and CEO, Validea.com And Validea Capital Management

John Reese, editor of Validea Hot List, who ranks stocks based on criteria used by top investors, finds two stocks he thinks might appeal to the former master of Fidelity Magellan.

HealthSpring (NYSE: HS) is a managed care organization with a primary focus on Medicare, the federal government-sponsored health insurance program. As of December 31, 2009, the Company operated coordinated-care Medicare Advantage plans in Alabama, Florida, Illinois, Mississippi, Tennessee, and Texas.

The company also offers prescription drug benefits in accordance with Medicare Part D to its Medicare Advantage plan members [and others], in addition to providing other medical benefits plans.

[Based on Peter Lynch’s strategy of focusing on P/E ratio to earnings growth, it earns a] Guru Score of 93%.

[Under Lynch’s method,] the investor should examine the price/earnings ratio (around 9x) relative to the [earnings] growth rate (46.12%), based on the average of the three-, four-, and five-year historical EPS growth rates for a company. In this case, the P/E/G ratio for HS (0.19) is very favorable.

[Lynch’s] methodology likes to see [annual] earnings growth in the range of 20% to 50%. The EPS growth rate for HS is 46.1%, based on the average of the three-, four-, and five-year historical EPS growth rates, which is considered OK. However, it may be difficult to sustain.

[The] equity/assets ratio [is] a way to determine a financial intermediary's health. HS's equity/assets ratio (65%) is extremely healthy.

Return on assets [is] a way to measure a financial intermediary's profitability. HS's ROA (11.34%) is above the minimum 1%, thus passing the criterion. (The stock closed above $28 Tuesday—Editor.)

Western Digital (NYSE: WDC) designs, develops, manufactures, and sells hard drives worldwide to original equipment manufacturers (OEMs) and original design manufacturers (ODMs) for use in computer systems, subsystems, or consumer electronics (CE) devices, and to distributors, resellers and retailers. Its hard drives are used in desktop computers, notebook computers, and enterprise applications, [as well] as digital video recorders (DVRs) and satellite and cable set-top boxes.

It also sells WD-branded external storage appliances for personal data backup and portable or expanded storage of digital music, video, and other data.

[Based on Lynch’s strategy, it gets a] Guru Score of 100%.

[With a P/E of about 5x,] relative to the [average long-term] growth rate (38%), the P/E/G ratio (0.13) is very favorable.

The EPS growth rate for WDC is 38.1%, based on the average of the three-, four-, and five-year historical EPS growth rates, which is considered OK. However, it may be difficult to sustain such a high growth rate.

[The total debt/equity] ratio for WDC (8.49%) [is] exceptionally low (equity is at least ten times debt). This ratio is one quick way to determine the financial strength of the company.

Lynch defines net cash as cash and marketable securities minus long-term debt. According to this methodology, a high value for this ratio dramatically cuts down the risk of the security. The net cash/price ratio for WDC (35.21%) is high enough (above 30%--Editor) to add to the attractiveness of this company. (WDC closed at about $33 Tuesday—Editor.)

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